Debt Trading and Securitization
The trading of debt and asset/debt securitization in Islamic finance is set to increase over the next few years as both central banks and money market in the Muslim world introduce measures to bolster the establishment of an Islamic capital market. This despite a clear difference of opinion between regulators, bankers and Shariah scholars in the Gulf States on one hand and in south East Asian countries such as Malaysia on the other hand. DR. Zaki Badawi, Shariah Consultant to Islamic Banker, examines the issues and stresses that neither regions need not lose out nor workable solutions can be found to meet changes in circumstances.
The question of debt trading is of crucial importance to the Islamic banking movement. A debt can be either monetary, or a commodity such as food or metal. The Shariah permits the selling of such a debt by its equivalent in quantity and time of maturity by way of hewalah (the transfer of a debt from one person to another with the agreement of the creditor).
This form of debt trading is accepted by all Schools of Islamic Law. It is regarded by same as an exemption from the rule attributed to the Prophet Muhammad, that a debt should not be exchanged for another debt. The HambaliSchool however does not recognize this rule as being authentic; selling a debt for cash is permitted providing it is paid in full and thus gives no benefit to the purchaser. The rationale for this ruling is that financial transactions involving debt should never allow for a payment against the length of the period of the loan, as this would be regarded as riba.
It is permissible for the creditor who wishes to settle the debt before maturity to accept a reduction in the amount due to him. This is called Hatitak, and is based on Hadith (Tradition) of the Prophet Muhammad, who advised certain creditors to accept reduced payments of debts in recognition of settlement before maturity. Some Schools of Law reject this procedure as a general rule. Their view is that the ruling of the Prophet is specific to the reported incident They reason that if this is allowed, it would open the gates for riba; others however consider that this procedure can be accepted in terms of a gift from the creditor and a favor from the debtor. To me this procedure can be abused by taking advantage of a creditor's temporary difficulty. A situation however might arise making the Hatitah procedure appear justifiable, for example, if a car salesman offers a car for sale for £10,000 with immediate payment, or for £12,000 with payment after two years and the purchaser chose the delayed payment, but then should decide on settling the account after one year, it might be justified to settle for less than the £12,000 of the original debt.
Shares trading are permitted by all Schools of Law as it is seen as trading in assets. But trading in bonds is a subject of dispute on two counts: first, the bonds are normally sold at less than their nominal value; second, the State pays interest on the value of the bonds. Both of these are regarded as riba by the majority of scholars and for this reason Islamic banks refrain from bond transactions.
A minority of scholars including the Mufti of Egypt, Sheikh Muhammad Tantawi, legitimize trading in bonds under the Law of Necessity. The Mufti reasons that the State issues bonds to obtain capital for the use of essential development that is of great benefit to society as a whole. He therefore regards bond trading permissible under these circumstances.
It should be pointed out here that there are two schools of thought in Temporary Muslim jurisprudence. The first recognize current developments in financial transaction and seeks to interpret the law in keeping with these developments, thus allowing; for most of the new financial product to be absorbed in the Islamic system the second sees the Law as fixed on the form of transactions that prevailed at the time of the birth and development of the school of Law. There is always a need for a conservative outlook to safeguard against total abandonment of the Law, and equal need for a trend towards new developments to meet changes in circumstance. The tension between the two trends should normally bring forth an acceptable compromise.
SECURITIZATION OF DEBT
Debt can be securitized in the following ways:
- Rahn, that is giving the debt against a collateral such as property or other assets owned wholly or partly by the debtor providing the collateral is at least equivalent to the debt Should the debtor fail to pay, the creditor would be entitled to realize the debt by selling the collateral. If any balance remains after the sale this will be returned to the debtor.
- Dhaman, which is a guarantee given by a person or an institution, e.g. a bank, to honor the debt should the debtor fail to pay the guarantor is expected to be in a stronger position to pay, than the debtor.
- Ta'min which means insurance. This has to be through an Islamic insurance company rather than a conventional insurance company. Some scholars however accept insurance, whether Islamic or not it is legitimate for the creditor to demand that the debtor insurance company against failure of payment. There is no violation of Muslim law in this respect.
- Hewalah, as explained above. This might be regarded not as a guarantee but are placement of the debt. It is agreed however that should the new debtor fail to pay because of bankruptcy, the creditor may demand payment from the original debtor.
ASSET SECURITIZATION
Use of capital in business is clearly subject to risk to reduce this risk somewhat and also to guard against sharp market fluctuation of property, partial or total, a variety options can be followed under the shariah insurance against partial or total loss can be entered into as mentioned above. Many Islamic banking institutions have introduced insurance policy based on takaful that is an association of business each donating a specific sum to a general fund to meet the loss that might be suffered by any member of their association. This method avoids the Gharar associated with the normal insurance policy. Strict scholars regard such a policy unacceptable on the grounds that the insured who made no claims against the company had lost his premiums for nothing whereas the one who made a claim may have obtained much more than he paid so that he would be regarded as "devouring others' property wrongfully" (The Quran: C:2 v:180).
Other scholars accept insurance with ordinary insurance companies. They look upon it as new practices which serves the interests of the business community and in which Muslims may to legitimate partake. Securitization againsts market fluctuation. The holders of assets' may enter into a hedging contract. This is in effect a promise of selling or buying at a specified date in the future at a specified price. This form of contract is in accordance with the Shariah. There is a discussion between the various Schools of Law as to whether the promise is binding. In modern business practice such a contract is registered and therefore is legally binding. Hedging contracts are based on the futures market. This in turn is determined by practitioners -who predict the future values of assets or commodities using their knowledge of the fluctuation of supply and demand and the relative performance of companies and institutions. There is however a problem with the futures market relating to the position of the middleman, the speculator, who mediates between the seller of the commodity and its buyer. He sometimes enters into a sales agreement of assets which he does not possess. This contravenes a rule attributed to the Prophet Muhammad prohibiting the sale of assets not owned by the seller.
Some scholars however define possession as being potential, not actual. So if a person promises to deliver goods which he does not possess at a future date, but is likely to obtain them the contract is valid. For example, a person sells a 100 tons of cotton, well before the season; such a sale is valid because the possibility of acquiring the 100 tons is great. If however the probability of the object of the sale coming into the ownership of the seller is remote, then such a sale is prohibited. Scholars cite the example of selling a runaway camel which has disappeared into the desert. We can cite the modern equivalent of the sale of a stolen motorcar which the owner is most likely to recover.
CONVENTIONAL / ISLAMIC ALTERNATIVE / UNDERLYING ISLAMIC CONTRACT / TERM
Revolving Underwriting Facility (RUF) / Murabaha Notes Issuance Facility (MNIF) / Murabaha / S/M
Notes Issuance Facility (NIF) / Shahadah Al Dayn or Certificates of Debt / Bai' Bithaman 'Ajil or Musharaka / M/L
Equipment Trust Certificates (ETC) / Ijara Certificates / Ijara / M/L
Bonds / Mudaraba Certificates / Mudaraba / S/M/L
Zero Coupon Bonds / Islamic Debts Securities / Bai' Bithaman 'Ajil / M/L
Mortgage Backed Securities / Islamic Debts Securities / Bai' Bithaman 'Ajil / M/L
Factoring / Musharaka / Musharaka / S
Bankers Acceptance / Islamic Accepted Bill / Musharaka / S
Preference Shares / Musharaka Preference Shares / Musharaka / M/L
S=Short M=Medium L=Long Source: Wan Abdul Rahman Kamil, Abrar Group, Kuala Lumpur, September 1985
***By: DR. Zaky Badawi